Fed Program to Spur Loans May Start With Few Deals (Update2)

By Scott Lanman and Sarah Mulholland


March 13 (Bloomberg) -- The Federal Reserve’s program to revive the market for securities backed by consumer loans may start with just a handful of deals, according to participants in the preparations, delaying its prospects of easing the credit crunch.

Today, the Fed delayed by two days the March 17 deadline for submissions of proposed packages of debt that investors can buy with Fed financing. No agreements have been announced yet for proposed securities. Brokers and investors have had difficulty agreeing over contract terms for the Term Asset-Backed Securities Loan Facility, the people said.

“The stakes are quite large,” and it will be critical that the start of the program “gives reason for hope” that investors will ramp up demand in subsequent operations, said former Fed governor Lyle Gramley. “If they were to dilly-dally not just for weeks, but for months, it would be a black eye.”

Treasury Secretary Timothy Geithner is counting on the so- called TALF, a joint program with the Fed, to expand to as much as $1 trillion to unfreeze credit markets. Any sign of failure of the effort may leave lenders less willing to boost lending for everything from car purchases to farming equipment.

The TALF’s $200 billion first phase would finance AAA rated securities containing loans for autos, education, credit cards and small businesses. Officials eventually plan to finance other assets, including commercial mortgage-backed securities.

First Round

Fed Chairman Ben S. Bernanke and fellow policy makers may be watching the results of the TALF’s first round as they meet March 17-18 in Washington. The Federal Open Market Committee’s last statement, on Jan. 28, said officials will continue to “assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity.”

The New York Fed bank is administering the program, which was announced in November. The bank said in a statement today on its Web site that the two-day extension “was requested by market participants in order to allow more time for borrowers to complete the documentation associated with the initiation of the program.”

“We’ll see a slow ramp-up in this process as people get more comfortable with their obligations,” said Reed Auerbach, co-chief executive officer of law firm McKee Nelson LLP in New York, who is working with issuers and underwriters on the TALF. “I don’t think this month will be indicative of the level of activity going forward.”

Original Plan

The Fed originally planned to start the TALF in February, then delayed the start to ensure “all our legal and procedural steps had been taken,” Bernanke said in congressional testimony Feb. 25. On March 3, the Fed and Treasury said applications for the first deals would be due on March 17, with loans disbursed on March 25.

The program has been complicated by the number and variety of interested parties, including underwriters, issuers, dealers and investors.

Under the TALF, investors such as hedge funds would borrow $84 to $95 from the Fed for every $100 in ABS posted as collateral, meaning they will put up $5 to $16 of their own capital, depending on the type of security.

Initial interest rates on the Fed’s three-year loans will vary from about 1 percent to 3 percent, also depending on the collateral. Investor returns will stem from the pricing of the securities.

Treasury is providing $20 billion in capital from the Troubled Asset Relief Program to protect the Fed from losses. Geithner plans to increase the contribution to $100 billion, allowing the Fed to expand the TALF to $1 trillion and add other assets such as commercial mortgage-backed securities.

Cornerstone of Plans

President Barack Obama has characterized the TALF as a cornerstone of his plans to reverse a self-reinforcing cycle of shrinking credit and economic contraction.

“This administration is moving swiftly and aggressively to break this destructive cycle, to restore confidence and restart lending,” Obama said to a joint session of Congress on Feb. 24, without mentioning the program by name.

Geithner told lawmakers yesterday that the TALF is “a very powerful program to help jumpstart lending to small businesses, student loan markets, consumer credit markets, auto finance markets.” He said at a Senate Budget Committee hearing that the effort “goes around the banking system to try to get the securities markets working again.”

The Managed Funds Association, the main trade group for hedge funds, circulated a “fact sheet” on March 11 outlining 15 concerns of its members with a customer agreement provided by primary dealers, the 16 brokers who trade with the New York Fed’s markets desk and help the central bank implement monetary policy.

Signed Off

Attorneys for the dealers revised the contract, though many investors hadn’t signed off on the terms, one participant said on condition of anonymity.

The primary dealers include securities units of Goldman Sachs Group Inc., Morgan Stanley and UBS AG.

Each round of debt offerings after the first will be due to the Fed on the first Tuesday of every month through December, the current end of the program’s authorization by the Fed’s Board of Governors.

The April round will add further types of securities, including ABS backed by vehicle-fleet leases and loans for business, construction and farm equipment.

“This is for restarting a credit market that has been frozen,” said John Ryding, founder of RDQ Economics LLC and a former Fed economist. “That’s a process that’s going to take time.” Eventually, “it’s going to work and it’s going to work very significantly over time,” he said.